The Broadbent Blog

Canada falling behind on innovation

on March 22, 2014
Posted by Mariana Mazzucato

While we tend to celebrate private entrepreneurship, the state is crucially important in driving and shaping innovation. The question of which economies will thrive and which will lag behind on innovation has a lot to do with sound public policy.

With an economy historically reliant on natural resources and one with high rates of foreign ownership, the role government plays is even more important for Canada.

For 30 years Canadian economic policy has been focused on the supposed need to liberate private enterprise from the heavy hand of the state. The focus has been on slashing corporate tax rates, reducing public interest regulation and liberalizing trade and investment.

But has this “pro-business” agenda worked?

Since 2000, the Canadian economy has actually regressed in terms of producing highly innovative products and services for global markets, with major technological champions from Nortel to BlackBerry foundering. Over the last decade, labour productivity in Canada grew at a dismal pace and Canada is running record high trade deficits.

The key to Canada’s falling competitiveness is the fact that Canadian firms are not reinvesting their profits in areas that support long-run competitiveness — human capital and especially research and development. In 2011 the Canadian Conference Board gave Canada a “D” on R&D spending, ranking 15th out of 16 peer nations.

Canadian governments played vital roles in the development of innovative sectors in the past, for example in aerospace and information technology. Since then, however, the Canadian economic landscape has become increasingly dependent on natural resources, with privatization of the profits from its exploitation retarding rather than supporting industrial policy.

While profits may soar when taxes fall, investments don’t. Canadian businesses are hoarding cash at record levels — $626 billion according to Statistics Canada — and the investment that is taking place is in the resource extraction of the old economy rather than the innovative technologies of the new economy.

The combination of lagging private sector investment and public sector austerity puts Canada’s ability to be a world leader in new technologies in doubt.

As I discuss in my recent book, The Entrepreneurial State: debunking public vs. private sector myths, evidence shows that only in countries with active innovation policies, in which the public sector is willing to take on capital intensive and high-risk areas, does the private sector follow. While recent policies in Canada have been directed at producing a dynamic Silicon Valley type economy, the policies have ignored the simple fact that Silicon Valley emerged from massive state investments: all the technologies that today make the iPhone so smart were government funded.

Indeed, the new Silicon Valley hero investing in electric cars, Elon Musk, has also relied on government playing entrepreneur with Barack Obama providing the early stage $500-million guaranteed loan for Tesla. We often view the United States as the poster child for free enterprise, but my research demonstrates that even in the U.S. it is active industrial and innovation policy that gets business roaring, not tax cuts.

In Canada, profits from natural resources should be returned more substantially to the public purse that has fed their development, investing in education, research and areas that will fuel future greener growth.

Evidence shows that it is only those countries that have substantial public finance in place that can direct support to emerging technologies. Looking at worldwide investments in renewable energy aimed at the global challenge of limiting carbon emissions, the figures are striking: state investment banks contributed 21 per cent of all finance for renewable energy projects in 2012, while the private market for green bonds to finance renewable energy projects added just 2 per cent of total investments.

Yet Canada lacks both the kind of large public spending that drives the U.S. innovation machine in the departments of Defence, Energy and Health, and the kind of public banks driving competitiveness in Germany, China and Brazil. The export development corporation is a partial exception, an institution that could be fruitfully expanded upon.

To rebalance Canada’s economy and return it to growth that is smart and driven by innovation, the government needs to refocus and redirect its energy. This will involve taking bold and decisive steps on investments, restructuring key areas of the economy such as the financial sector, and a shift to industrial policy that favours innovation and investment. Tax and spending cuts without strategic investment in key productive areas will not work. They have and will continue to fuel an increasingly unequal Canadian society.

Mariana Mazzucato is R.M. Phillips Professor in the Economics of Innovation at the University of Sussex. She is delivering a keynote at the Broadbent Institute Progress Summit on March 29.